18/4/15: Fitch Postpones Russian Ratings Review on Improved Data

As noted yesterday, both Fitch and S&P came out with (well, sort of came out in Fitch case) updated ratings for Russia. I covered S&P ratings here: http://trueeconomics.blogspot.ie/2015/04/17415-conservative-to-surprising-degree.html

Now onto Fitch.

According to the Russian Finance Minister, Anton Siluanov, Fitch postponed formal ratings review and held Russian ratings at BBB- - just a notch above junk grade. Fitch, thus, retains the only non-junk rating for Russia amongst the Big 3 agencies, with S&P at BB+ and Moody's at Ba1. According to Siluanov, the postponement reflects improved data outlook for the Russian economy.

Fitch was the first of the Big 3 to cut Russia’s rating back on January 9 (see http://www.reuters.com/article/2015/01/09/fitch-downgrades-russia-to-bbb-outlook-n-idUSFit89012120150109). Since then, Russian eurobond issue, maturing 2030 posted a 13 percent plus rise. In part, this reflects firming up of the ruble, and to a larger extent - the unprecedented levels of liquidity flowing into sovereign bonds markets worldwide. But in part, improved yields are also reflective of adjusting expectations concerning Russian economy. For example, alongside their February downgrade, Moody's estimated Russian capital outflows for 205-2016 at USD400 billion and Russian GDP was forecast to fall by 8.5%. Current consensus in the markets is that outflows will be closer to USD150-170 billion (on expected debt maturities) and the economy is likely to contract by closer to 4-4.5%.

Capital outflows figures stabilisation has been rather significant, especially given the level of debt redemptions in 1Q 2015 (see here: http://trueeconomics.blogspot.ie/2015/04/14415-russian-external-debt-redemptions.html). In 1Q 2015, estimated outflows totalled just USD32.6 billion, compared to USD77.4 billion in 4Q 2014 and with USD48 billion outflows in 1Q 2014. While banks continued to deleverage, non-financial sector was able to roll over much of maturing debt and were repatriating assets into Russia. The net result was inflow of forex into the Ruble market.

Deleveraging in the Russian economy is going at a breakneck pace: in mid-2014 Russian external debt (over 90% accounted for by private sector) stood at just over USD730 billion. By the end of 1Q 2015 estimated external debt has fallen to USD560 billion, implying net debt reductions of USD170 billion over the span of 9 months, well above my earlier estimate of net repayment of USD96.5 billion that excluded Ruble devaluation effects. The USD170 billion estimate includes devaluation of the Ruble and roll-overs when these involved conversion from forex-denominated inter-company loans and equity into Ruble-denominated ones. It is worth remembering that roughly 1/4 of Russian external debt is denominated in Rubles.

When it comes to sovereign ratings, it is also worth remembering that Russian public sector external liabilities amount to less than 10 percent of the total external debt.

Overall, Fitch decision to hold Russian ratings under review is a reflection of the recent improvements in the economic outlook, but also the fragile and early nature of these. As I noted on numerous occasions before, the situation is fragile and the risks to the downside are prominent, so Fitch's more cautious approach to ratings is probably better justified by the current environment.

17/4/15: Conservative to a Surprising Degree: S&P Russia Ratings

Two ratings agencies updated their ratings for Russia today. Here are some highlights:

S&P first (Fitch later, so stay tuned):

S&P kept Russia’s foreign-currency credit rating at BB+ or one step below investment grade with negative outlook. ""We are affirming our 'BB+/B' long- and short-term foreign currency ratings and our 'BBB-/A-3' long- and short-term local currency ratings on Russia".

The agency claimed that Russian policy makers are struggling to boost growth and the country financial system risks are increasing due to continued external funding drought caused by the sanctions. Per S&P statement, “Our base case assumes that the sanctions on Russia will remain in place over the forecast horizon, absent a resolution of the conflict in Ukraine.”

S&P first pushed Russian ratings below investment grade on January 26, based on the adverse impact of lower oil prices and ongoing sanctions.

The rating came in as expected, though negative outlook might be a touch gloomy for some observers. The reason is that since January, Ruble gained significant ground in value, while capital outflows projections for 2015 improved (in 2014 Russia experienced capital outflows of USD154 billion, and 2015 latest forecast is for outflows of USD90 billion). Ruble trade at 68.0 to USD back on the day of S&P previous decision, today it is around 52 mark. Growth outlook is stabilising, albeit remains highly challenging. Inflation is matching S&P previous expectations, but against lower CBR rates. Ukrainian conflict drags on, for sure, but there is at least a fragile pause in place and if in January new sanctions were looming, today there appears to be no momentum for their introduction. Finally, oil was at around USD48 pb then, at USD55 pb now. Russian authorities have said this week that they may return to foreign borrowing markets in 2016, while expectation in January was that the earliest date we might see Russian issuance in international markets is 2017.

On the higher risks side, March consumer demand appears to have worsened despite improved Ruble exchange rate as preliminary retail sales data shows a 8.7% drop y/y and consumer sentiment index down 14 percentage points on Q4 2014. Economy is expected to post a contraction of 2-4 percent in 1Q 2015. Preliminary data suggests investment declined 5.3% y/y and industrial production is down 0.6%. Inflation is running at 16.8% annualised rate, but that is, actually, a slowdown from over 18% earlier this year.

Still, at 2-4 percent, things in 1Q 2015 are not as bad, and certainly not worse, that full year consensus forecast of 4.1 percent this year. And capital outflows eased significantly in 1Q 2015 to USD32.6 billion from USD77.4 billion in 4Q 2014.

So it is a mixed bag, but crucially, the economy is performing close to previous expectations, with no significant downside surprise between January and today. Which means that it is rather unclear which part of expectations forward warrants 'negative' outlook, given there is already a 'negative' outlook reflected in the affirmed ratings?

S&P tries to explain: “The outlook remains negative, reflecting our view that we could downgrade Russia if external and fiscal buffers deteriorate over the next 12 months faster than we currently expect. We could also lower the ratings if Russia’s monetary policy flexibility were to diminish further.”

But contrasting this, is S&P own outlook published in recent weeks covering key sectors and economic activity. In April 13 note, S&P estimated that 5 largest Russian banking groups have lost USD4-5 billion in 2014 (ca 20-25% of their aggregate operating income) due to their exposure to Ukrainian assets. But forward outlook is not exactly any worse, as S&P said that 2015 losses from the same can be about the same. More significantly, S&P said that they "…estimate that Russian banking groups face aggregated Ukraine-related risks of less than 3% of their aggregated assets…. We nevertheless believe that Russian banks can withstand such costs, and that there will therefore be no rating impact for rated Russian financial groups."

And more. On April 7th, S&P itself upgraded outlook for the Russian economy: S&P own forecasts now expect 2016 growth of 1.9% (as opposed to 0.5% consensus forecasts) and a recession of 2.7% in 2015, as opposed to January 2015 forecast of 0.5% growth in 2015 and zero percent growth in 2016 and against the consensus forecasts cited above.

S&P is not the only research outfit upgrading Russian growth forecasts: JPMorgan revised recently its 2015 forecast from -5% to -4%. Russian official forecasts are also 'stabilising': Ministry of Economic Development forecasts +2.3% for 2016 and +2.5% over 2017 and 2018. CBR forecasts a drop of 3.5–4% in 2015 and growth of +1–1.6% in 2016, rising to 5.5–6.3% in 2017.

The bizarre nature of ratings agencies analysis - including inherent own-contradictions and lags - is one of the reasons why the CBR recently said they are considering gradually abandoning Big 3 agencies ratings for the country banking sector. The move would involve developing internal ratings system and, potentially, relying on other agencies in the mix.

Conclusion: altogether S&P latest ratings make some, but very limited sense and are conservative. So let them be. Russian bonds have been rallying recently and as long as oil stays firm-ish and Ruble does not experience another run, this rally will continue in the medium term. Any adverse repricing of bonds on foot of today's S&P action (and potential downgrade by Fitch) can actually create opportunities for distressed debt buyers, which will firm up prices again. Globally, there is too much money chasing too few bonds, so spike in yields in the short run can be seen by some speculators as an opportunity to pile into Russian paper. 

(Please, do not confuse this with an investment advice, as usual, for I do not do that sort of thing).